Matt Bank - "GEMs" of Risk, Asset Allocation, and Manager Selection (EP.419)

25:59Or are they satisfied with just meeting the return goals over time, preserving intergenerational equity and preserving the real value of that corpus? And that becomes a choice that the committee has. There are a lot of institutions, in particular, I think, post-COVID that are going in very different directions. Higher ed is a classic case where you have one college or university closing or merging with another every week now. On top of that, you have an enrollment cliff coming around the pike because people stopped having children in the global financial crisis. And so those kids would be 17 or 18 years old now enrolling in college in theory, but there's going to be 15 % fewer of them over the next few years.

26:38So there's some real strategic issues that a lot of institutions in that space in particular are facing. And there's similar versions of that if you look at foundations or healthcare systems. They all have their own idiosyncratic business issues to deal with. And the key is understanding what can the institution bear and then what is the committee trying to accomplish with the assets to help it with its mission. So the end of that enterprise assessment, you can imagine some type of a spectrum of, you could say risk tolerance or what they're trying to accomplish. You then have to put that into action.

27:11How do you think about what to do now that you've made that enterprise assessment? The nice thing about it is each of those risk factors that we talked about, shortfall risk, drawdown risk, illiquidity risk, variance risk, maps pretty cleanly to a form of risk exposure that you might have in the portfolio. You know, as an endowment investor, that your nominal return goal is going to be high enough that you need a very healthy dose of equity in there. It's going to have to be at least half of the portfolio, probably a little bit more than that. And then the question is, what forms of diversification away from that do you need to incorporate?

27:48The first thing for us is always deflation hedge in the form of interest rate risk. There are also periods of unanticipated inflation beyond that. You use things like commodities and real estate to hedge those particular periods. And you can run all of these factors through your model and figure out what is the optimal mix that gets the client to its goal within the constraints of its risk budget. You overlay, obviously, the alpha you think you can generate in each of the opportunity sets that you'll ultimately leverage. How much can you get from private assets? How much can you get from public assets, et cetera?

28:22And bolt that on top of what the beta is providing you from a return perspective, but it's a fairly straightforward model. I don't believe that we're trying to win in terms of portfolio construction in the way the assets are assembled. We're mostly trying to win through manager selection within those tools, but the key is making sure the portfolios are arrayed in a manner that's aligned with those goals. So you said there's a range, and there are. Some clients have more equity exposure because they can tolerate more drawdowns and they're seeking a higher return goal over time. Some have lower illiquidity targets because they need more access to variable capital or they need it more frequently.

28:59Those two end up being big drivers. Passive and active is another component of this conversation. If you have low variance risk, then maybe some of your equity exposure should be passive or indexed in a manner that's going to reduce your tracking error to underlying benchmarks. And you'll have to make up for the loss of alpha from that somewhere else. So these are all trade-offs that you make over the course of a modeling exercise. So in this phase 3.0, when you've made these trade-offs, you mentioned alpha is going to be super important. You got to get there through manager selection. Let's walk through that process of sourcing of managers.

29:35It's varied by the asset type, but I think at a very high level, we're looking for three things. We're looking for skill. We're looking for an attractive market. And we're looking for alignment of interests. So break down each of those in turn. And skill, absolute skill is pretty easy to find these days. Everybody out there is well-trained. They've got a great story. Looks really good. The question is, what's the relative skill? This is a Michael Mubison concept, this paradox of skill, that when the aggregate skill level goes up in a universe or a population, luck has a disproportionate effect on the outcomes.

30:11The key is finding these games that you can play within these different markets where relative skill is really what's dominating the outcome. We spend a lot of time trying to figure out who's got some kernel of excellence that leads them to have an advantage relative to their peers or competitors. Ideally, it's durable. No edge is ever fully durable. And ideally, it's predictive of better outcomes. In public markets, those things can be an aspect of portfolio strategy. It could be risk management. It could be analysis. It could be temperament that leads you to a view that this person has a chance to be excellent relative to everybody else that's in competition.

30:53In private markets, that's sourcing capability. It's oftentimes deal hustle. It's structuring. It could be operational chops, depending on the nature the strategy pursued. How do you go about assessing the difference between two managers, so let's say public markets, that seem attractive on a lot of those characteristics, but you really only want one for your portfolio? Public markets are, in my view, very interesting because you typically have a lot of data. And as a result, you get a chance to look at trading history. You get a chance to look at letters they've written in advance of market moves and understand what was the thesis?

31:33How did that play out? We spend a lot of time with managers talking through decisions they've made and why. That's the primary driver of it. You see the data and you ask people what their rationale was for when things transpired, why they transpired in that way. You're always trying to disentangle luck and skill. There have been situations where people are right for the wrong reasons and you ding them for that. And there are times when people are wrong for the right reasons and you try and give them credit for that. And then you try to make sure that you examine that data and those conversations over a long enough period of time that you get different market environments.

32:10I always joked after COVID, we learned more about our managers in those six months than we had in the prior six years. Because you see how they react to market stresses and stimuli in a different way. Temperament ultimately becomes a key feature in this that you often don't get enough iterations to really see. But some managers that we were watching turtled during that period and didn't turn over their portfolios. And others really rose up and traded out of things that had a 20 % forward IRR for things that had a 30 % forward IRR and were very active. And I think that element is something you just have to get through a lot of monitoring and discussion.

32:45So to get at more data requires more time. How do you balance your interest in a fund that's been around for a longer time, and therefore you have more data to assess with something that's earlier in their stage of development. There's typically things you can see for day one launches, and there's things you can't see. The thing you can see often is business analysis, research intensity. You can reference those things with peers and former colleagues and bosses. What you can't see are things like portfolio management and temperament. You spend an inordinate amount of time trying to predict how people will behave and act, but it's always imperfect.

33:25There's other things that can creep up that cause challenges too. How is this person going to build a team over time to support them? Oftentimes, young managers haven't had to deal with that. We try and lend our expertise in some of those areas to help them through those processes. But again, you don't know ex ante. Part of it is how you size and how you control the risk within your own portfolio. I think we're always trying to build conviction. One of the things that we do with a lot of relationships is look to secure capacity rights in the future. That tends to be the scarcer resource because once it's obvious, the manager's good, it's too late.

33:57And so you'd better have a relationship early. You better have added value in some other way to them. You've better been a good LP along the way. So we just try to make sure that we're crawling, walking, running with people who are building their own firms for the first time. So in the context of doing your due diligence, I'm curious if there are any techniques, questions, processes that you have that help you get there. There always are. I won't reveal all the secret sauce here, but I think we've tried to take a very multidimensional and multidisciplinary approach to this issue. The team is extraordinary that we have.

34:31They are very well experienced in this. We have years of networks and relationships that we can draw on to ask about people and their pasts and what their work style has been. And then we look at other forms of insights. We had someone from an intelligence agency come in years ago and give us a tutorial on how do you detect deception? How do you read body language? It's an interesting insight into other ways to sit across the table from someone and how to glean information. We spent a lot of time on how do you ask questions? It sounds like a very basic thing, but analysts come in and people don't know how to ask questions, particularly questions that are open-ended enough that it leads you to truthful, candid answers.

35:14Getting people to ask questions that are not leading, that don't guide somebody to the correct answer is very difficult actually. You have to ask things in a way and in a manner that gives people across the table from you permission to answer it in the most candid way that they can. That's another art form that I think goes into this that is subtle and we're constantly trying to improve on to make sure that the answers that we get are most instructive in leading us to the truth. Is this person really good? Have they been successful because of the skill that they have? Is that skill durable? And can we underwrite it and back them in the future because of it?

35:52What are some of your favorite tips for how to ask good questions? The biggest one is being quiet after you ask. There is a strong tendency psychologically to fill space with words. Oftentimes it's elaborating on a question or changing the framing of a question if you don't immediately get an answer. And instead of doing that, just be quiet. Just hush up, let the person sit with it and figure out how they're going to deal with it. That tends to be the biggest thing you have to coach out of people. The other one is asking things that are truly open-ended, meaning you're not encouraging a particular form of response.

36:34You just ask it in a manner that is almost curt sounding when you phrase it, because you need them to not only answer it, but interpret what it is you mean. And oftentimes, they'll get anxious about that if the interpretation could be in a negative way. So there's a lot of little tools and tricks, and the team is constantly trying to refine those and share them. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past? Partner with a company that's been defining the future of dealmaking for nearly two decades instead.

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38:04Privates are very different in the sense that you typically have a decision point, which is, are you going to commit to the fund or are you not going to commit to the fund? You watch people who focus on public markets and there's this constant rumination that goes on about, okay, the quarterly letter comes out. How is the arc of the thesis evolving? How has the market moved? There's a very pensive process that goes on in constantly evaluating the public managers. Private side, it just tends to look more transactional and execution oriented. And that's the nature of it. In the underwriting process, though, it's a fairly similar exercise.

38:42guys. We try to understand what has led to a person's success. We do a lot of references on individuals. Again, it depends if there's an established track record there or if there isn't, if it's a new manager to us or if it isn't. You obviously have a lot more insight into the portfolio and where things are likely to go if you've been in funds one, two, and three, and this is a re-up for fund four. But is the sourcing edge still in place? Do they have a credible path to generating a 3x net return. That's our bogey for private markets. We expect private equity in particular to deliver five to 7 % ahead of public markets over time.

39:17And does the strategy and does this manager allow for that? Fund size is probably the number one aspect that we underwrite. Is the opportunity set allow for them to deploy this amount of capital? Is the team structured in a way to allow them to deploy this amount of capital? There are some strategies that are much more operationally intensive. Buy and builds, for example, if you're going to do a A lot of add-on acquisitions, the integration processes are difficult. Do you have a team that can support eight to 10 platform businesses and the associated taxes that come along with that? Those tend to be the big ones.

39:49I think when you're dealing with emerging managers on the private side, oftentimes it's a challenge to associate a track record specifically with them. So that really raises the bar on what you have to reference. You're calling not only peers and colleagues, but CEOs of portfolio companies that they were involved in. other people they may have associated with at different phases of life to try to put together a mosaic of how successful this person is likely to be, why they're spinning out on their own, and what it is that's going to lead to success in the future. For the corollary of public market managers, how do you think about the assessment of data that is available?

40:26In normal times, when there are distributions and other sorts of things that lead to funds opening and closing and having a natural life cycle, you do have quite a bit of data. It's not a lot of swings. And we've had situations where a manager's historical track record is mixed at the firm that they're with. And yet, we decide it's a good investment opportunity given how they've reshaped their approach, what their deal box is, where they're going to spend their time, how they've built the team, what their sourcing edge is. So you have to take it in context. I think one of the things that we've done over time is backed managers in a deal-by-deal format in an independent sponsor context.

41:05That's been compelling for a number of reasons. One is the returns that have been associated with that strategy have been excellent over time. Another though, is that you get a lot of insights into how deals evolve that you wouldn't have gotten otherwise. That as a fund one LP trying to diligence a pre-fund track record, you would not have been able to monitor over time. Obviously, you're doing this all ex post. Watching someone live through a collection of deals, engaging with them along the way, helping them navigate different things that pop up with businesses, CEO resign, something goes wrong, COVID happens, is incredibly helpful.

41:45One of the things we've done, obviously, to amplify our own ability to underwrite these things is just get in earlier and do things on a deal-by-deal basis, where then you can build conviction into a fund one commitment. When you started doing the deal-by-deal investment and then analysis, I'm curious if there are things that you learned because you had, say, more transparency into what was going on that you weren't quite sure how to calibrate because you hadn't done that as much as investing in funds. Yeah, I think there are always learnings here. We started this process in about 2015. My partner, Jay Ripley, really led this.

42:21And it was born out of a series of visits to private equity annual meetings where they show you the page of performance track records and the pre-fund deals are great, three and a half X, whatever it might be. Fund one is good. Fund two is okay. Fund three is eh. Fund four and monotonically downward sloping returns as the assets under management grew. And so the joke was always, well, how do we get exposure to that thing, that first one? So there was a view that this was going to be a better opportunity set for us. There have certainly been a lot of learnings over time. One of those is how do you structure these types of engagements?

42:56Do you put them in a single vehicle? Do you have them in SPVs? How do you deal with follow-on capital? There's a whole slew of terms and conditions that really varied across the different strategies. Buy and builds are different from turnarounds or different from corporate carve-outs. How you supported a manager building a team over time, getting involved with conversations about when do you hire a CFO? What if you're having a partner issue? All of these things that sort of border on therapy, you learn over time how to navigate those and what the right guidance is and best practices, how to educate people on those sorts of things.

43:32And I think to constantly raising the bar on our sourcing apparatus to continue to find new folks and top grade. For a long time, the way this worked was we would look at all the big firms, typically firms that had a really compelling strategy, typically firms that didn't necessarily pay the moneymakers all that well, so there was an incentive to leave, and run through all those firms and figure out who the real stars were. That's a great method. It's a very crowded space now, and there are folks that are spinning out of all sorts of firms all the time. And so making sure that you have a dedicated sourcing apparatus that is constantly in this market, trying to make sure that we are the first call for them when people decide they want to leave, whatever middle market firm they're at.

44:22That has been a concerted effort over time. That was always part of it, but I think as the world gets more complicated and more crowded, that's becoming even more important. I'll give an example. Six members of our team were at the Maguire Woods Conference in Dallas last week, which is the biggest independent sponsor conference in the world. A number of years ago, there were a handful of capital providers. This year, there were 430 capital providers to go along with obviously a growing number of sponsors as well. Interestingly, about a quarter of those capital providers were people from other larger private equity firms who recognized that it's a sourcing apparatus for them to partner with independent sponsors.

44:59So the world has just gotten very crowded. We all have stories of people who are trying to roll up HVAC businesses and plumbing companies and paving businesses and things like that. But there are a lot of services opportunities out there and you have to be able to separate the wheat from the chaff. There's a lot of chaff. Finding those folks that have credible, referenceable track records and a real path to generating excellent returns, it requires a lot of proactivity. So this idea of finding an opportunity early, like independent sponsors, but then over time it grows and gets crowded, leads to this original question about the second assessment of markets next to manager assessment.

45:36And we just love your thoughts on how you go about assessing a market that a manager's participating in. At a very high level, I think you're looking for a dynamic where there's some advantage to be had. So corporate carve-outs are always been our classic example where on the other side was a big public conglomerate, new CEOs installed, wants to divest from a particular business unit that's underperforming. That's a great setup. They typically have a time clock where they'd like to get rid of that thing. And if you pay three times, four times, five times, eight times, it doesn't really matter.

46:08What the CEO can't do is show up to the Wall Street analysts next quarter and say, we still own this thing. So whatever it takes to get rid of it, they're gonna do. And that has been a really, really powerful dynamic. It turns out the lower the purchase price, the better your return prospects might be. Surprise, surprise. I think more broadly though, market assessment is about dynamics where an edge can be exploited. So biotech is another example where there's clearly in that marketplace an advantage to specialization. There aren't many like that in public markets where the generalists are clearly at a disadvantage to the specialists.

46:41You can develop an edge. You can develop an interesting viewpoint on different disease therapies and different drugs that are coming to market and win that game. And there's a lot of cases at all the endowments of firms that have done really good job in that space over time. China for a long time was a good market because the share of equities owned by retail investors is very high. And so in theory, again, back to the main point about relative skill, that's a situation where the skill dispersion is high. In theory of institutions trading with less sophisticated retail buyers, that should be an attractive market.

47:13And then there are some corners of markets that are just capacity constrained. And so you know that the large asset managers cannot play in them. Those with a significant efficient deployment of capital problem are not going to be there moving inefficiencies out of the way. And so those are situations that we also like. Those tend to appear more, again, in private markets or in sort of alternative betas than they do in public markets. When you're building your portfolios of managers. You like to have all of the managers in these alpha generating areas of inefficiency, but over time, things get more competitive and you kind of have to have a core of things that hopefully someone's outperforming, but it doesn't have that area of specialty.

47:54As you go to construct your portfolio, how do you think about balancing the two of the need to have core asset exposure with this constant search for something special? I think it varies a bit by the opportunity set. In public markets, for example, we think of about half of our portfolio should be in what we call foundational assets. So these are things that are going to provide you core beta, oftentimes quality like exposure, maybe tilt larger cap. You can't do the whole public equity portfolio in niche special situations managers to be sure. And then you have a couple of other buckets. You have structural opportunities.

48:30That may be things like biotech where regardless of the beta, you like the alpha opportunities so much that it's going to have a place in the portfolio. Then you have opportunistic assets where that might be related to dislocations or things that are more transitory, where those managers might come and go depending on where the opportunity set is over any given three to five-year period. And then you have this sliver, which we call diversifiers, which would be things to balance the rest of it. There are parts of public markets where active managers just don't go very much. Consumer staples, utilities, parts of energy sometimes, but you need those to manage your overall tracking error.

49:07So I think there's always a core satellite dynamic. We think about it in terms of how attractive is the beta, how attractive is the alpha. There are situations where you'd love to have everything where the beta was attractive and the alpha was attractive, but oftentimes those aren't always aligned. On the private side, same idea. You have more willingness to seek alpha there. First of all, that's the role it plays in a broad portfolio. So you need to generate alpha from the private side. But are there zero large buyout funds that can generate sufficient returns to have a place in our portfolio?

49:40Of course not. No. And we have several that are measured in the billions and they just happen to have compelling enough strategies that they think they pass the bar. The key on the private side is you have a much broader opportunity set. And so we have a lot more diversification there by manager and by strategy. That portfolio is just a longer list of line items than the public is. And so I think you have more degrees of freedom to get to a sufficiently diversified place through more diversification. On the public side, that core part of your exposure, how do you think about the movement to passive management?

50:14There's two kinds of passive. There is what I'll call anti-active, which is really a philosophical view that active management in public markets is a loser's game. to borrow Charlie Ellis' term, it can't win. No one can win. It's not worth trying. There are clients of ours that hold that view. And we are perfectly capable of building portfolios that incorporate a portion of a portfolio that's passive. I have a very strong view that the portfolio a committee can stick with is the best portfolio for them. And if you constantly bang your head against the wall trying to get someone to believe that active can be better, the first whiff that it underperforms, they will immediately scrap the whole thing and shift to passive at great cost to them.

51:00So we're happy to build a portfolio that has passive component to it. As long as people recognize you now have a higher alpha bar at the rest of the portfolio and therefore may need additional illiquidity or something else to try to increase expected returns. I think from here, passive, the anti-active version is just less compelling than it has been in a long time. If you go back to 2014 and you look at the expected returns for equities at that time, and you run it forward, it was about 4%. And what we've gotten is nine or something extraordinary. 1.8 standard deviations over what we expected at the time.

51:40If you do that from here, where expectations are even lower today, given where risk premium are and where valuations are, It's going to take more than 1.8 standard deviations from here to continue to meet the bar that a lot of clients have for their passive equity exposure. So I think the bar on passive has just gone up, in my opinion. It's hard to fight with people who have an anti-active view about that. It's an unwinnable argument. The other form of passive, which I'll characterize more like indexed exposure, for a long time, it was very difficult to find compelling active management in Japan.

52:12So what did we do? We plugged that beta. Similarly, in some of the segments that active managers don't often play, consumer staples, we view indexes as a compelling tool for balancing tracking error, for completing exposures, and making sure the portfolio is properly balanced. We use them that way. We typically don't use passive as simply a plug to reduce tracking error. When you are filling part of the portfolio with passive and you need that increase in alpha on the active side, you immediately think of venture capital. So I'd love to get your views of how venture capital going forward plays in your portfolios.

52:49Venture capital is an interesting part of its evolutionary cycle. It has been a primary return driver for a lot of leading endowments for a very long time. Interestingly, for a lot of that period, if you asked 20 of the largest endowment teams what their roster of the 20 best managers were in the space, you'd have, I'll be conservative here and say 60 % overlap in terms of what's on that list. So it was very much an access game. It was very much, can you get into as many of those folks as you possibly can to have a credible path to generating really good returns? We've just gone through a serious capital cycle in venture where post COVID, everything accelerated, valuations, assets raised, and now we're on the backside of that.

53:37And we are in the process of decapitalizing that space broadly. And that's going to have implications for how people use venture going forward. The base rate in venture has always been terrible. 60 % of venture capital firms generate less than cost. So not only are you not keeping up with equities, you're losing money in more than half of venture capital funds raised. It has always been a power law, right tail oriented asset class. Even for firms. firms. Yeah. And what you're seeing now is that there's still demand, tons of demand for what was on that list of best firms previously. Where we have really refocused our attention is engagements with those great brands that have been disciplined about fund size.

54:22There are a number of other firms that are great brands that have not been as disciplined about fund size that are now supermarkets for lower cost of capital investors. The space is institutionalizing very rapidly in that sense. And certain forms of alpha are becoming beta. They're selling a different thing. So engage with the brands that have been really disciplined here and then figure out who's going to be on the list of great brands five years from now. It's a really hard game adventure. Really, really hard. And historically, we had a view that, well, let's wait till fund three. Once we can see that this is working and the brand is established, you don't have that opportunity anymore.

55:02And you need to get in early in these situations. Our sourcing apparatus has turned on to seed and micro managers today, trying to figure out who is going to provide the returns going forward that's going to allow them to establish a credible brand. We just backed a group, raised$350 million for fund one. It's three partners coming together out of three storied franchises, they have a view that particularly series A and early stage founders are underserved by the multi-stage firms. They're small, multi-stage partners have other things to worry about, and there's a view that they can do a better job.

55:41So I think that's all part and parcel of an evolution in the strategy. The math of venture is just very daunting, particularly at mass scale. When you think about the likely probabilities that a certain number of companies are going to fail, certain are going to be middling outcomes. And then a very select few are going to be very right tail, extraordinary experiences. How big do those extraordinary companies need to be to justify the fund size? And even at 300 to$500 million, you need to be a part of a couple of$10 to$20 billion enterprise value companies, which is not small. And you need to avoid a dilution along the way to some extent.

56:22There's a lot of things that go into it. And if you're raising$5 billion, just multiply all those figures. You basically need one of five generational companies within that portfolio to meet the return bar. How do you think about hedge funds? Hedge funds for us have been a source of alpha in the sense that we want total returns. We've never really used hedge funds, not in a long time at least, for volatility dampening. We can do that in other ways. We just take down equity risk and increase bond exposure. So we wanted our hedge funds to be able to generate sufficient net returns that they were sort of compelling in their own right.

56:59That led us over time to a place where we had a lot of directional long short managers who had sufficient alpha that they could overcome some of the volatility dampening, just endemic to being less than one net. The portfolio overall today is about 50 % net exposure. We have some AR again. That's partially related to stock bond correlation going up in our view that going forward, you're going to need more diversified sources of portfolio protection. So we've done some things in reinsurance space. We've done some things in market neutral. We've done some things in arbitrage strategies. Hedge fund space in general is an interesting industry dynamic at play.

57:34Launches are down relative to history. It's getting harder and harder, I think, for a standalone single strategy manager to build a durable business. And some of that's related to what the pods, multi-strats are doing, hoovering up a lot of the talent that's out there. When you meet with those firms, you realize what an extraordinary data advantage they have in managing their talent and seeing where skill really resides and evaluating that on a minute by minute basis. And then obviously the leverage component is huge too. When you cut through the data, the long short spread of the equity long short strategies, the pods is good, not always world-class relative to what we see in other situations.

58:21But if you lever that three, four, five, six, seven, eight times, it becomes very, very compelling. So I think that shift of talent toward these bigger platforms is likely to continue. That'll have some consequences for the industry overall, but I think it's just fundamentally changed the game a bit in terms of how you get that exposure today. So let's turn to the last pillar of your assessment in alignment. When you think about alignment of your capital with your managers, how do you try to implement that? We have seen this every which way over time. There's forms of overalignment, there's forms of underalignment.

58:58I think what you're trying to solve for is, first off, what motivates the person across the table from you? What is the intrinsic driver of their commitment to success? Are they returns focused? Are they committed to integrity? Are they going to do the right thing, irrespective of whether this goes well or poorly? That becomes a critical analysis piece because you cannot structure your way into alignment if it is not inherent to the person you're across the table from. Now, you try to defend yourself in some instances. In terms of fee structure, we try to make sure that we're paying for alpha, not beta, paying for the outcomes that we're going to be happy with.

59:43And we try to make sure that the level of fees is appropriate for the strategy that the manager is running. And then you think about terms broadly as well. What's the liquidity of this overall portfolio? Is there a trade-off to be made there? What are capacity rights that you might secure? Because you don't want managers to outgrow the opportunity set too soon. And so you almost are willing at the early stages to pay a little bit more than you otherwise would in order to incentivize that form of behavior. You're trying to lead breadcrumbs down the path to really good outcomes for you and for the manager in a way that keeps everybody in the same boat rowing in the same direction.

1:00:21We don't want to be adversely selected either. A lot of times managers that are willing to negotiate with you on fees are not managers you'd want to invest in. One of the partners had a phrase long ago that was, we're trying to convince people who don't need our money to take it. That becomes the fulcrum challenge in a lot of these negotiations. And so sometimes you have latitude and sometimes you don't. This is another area where being early really matters, both on the public and private side, because you can help craft those terms and find ways to endear yourself to a manager. It will be treated well and fairly all the way through the relationship.

1:00:55How do you think about the impact of other LPs? So if you're early, there are other people that are trying to step in early as well. If you're later on, there are other LPs who may have had influence or continue to have influence along the way. It's a critical piece of our diligence. And I think the LP base can be a source of edge for managers, depending on who's in there. If at the first whiff of a downturn in a public markets portfolio, the person's on the phone with 16 different LPs, that's not a great setup for good decision making. You do really want to be aware of who else is in here. That doesn't mean you're deferring your diligence to those folks.

1:01:33We don't over-rely on who's done the work previously as a signal for quality. But it does tell you what other sorts of pressures is this manager going to have on them. We've had situations where leading university endowment for its own causes will try to persuade a manager to change his or her strategy. And in one particular instance, he called and said, geez, this institution's trying to get me to focus on this particular market. I think I'd be better served not doing that. And we encouraged him to do what he believed was right. Because guess what? if pivoting doesn't work, then that institution is not going to blame itself.

1:02:10The only thing you can do is do what you believe is right over time. And if that institution doesn't like it, you can find another LP. If your performance is good enough over time, you will be fine. And fortunately, stuck with it. And it's been one of our best performers over a long period of time, but it's really impactful. And you have to understand what the incentives are of the other LPs at the table. As you're investing today, and you look out over the next couple of years, What are the different ways you're thinking about the process of manager selection compared to what you've done in the past?

1:02:41There's always an arms race in terms of the execution here. And so our team is laser focused on how do you continue to scout and access talent effectively? I think there are a couple of things that are going to continue to be very important. Number one is relying on the causes that our clients serve. We are blessed to have this handful of clients who have discrete missions, things they support, programmatic objectives. And it is very rare for us to be unable to find a cause that really resonates with a GP within our client base. The universities have been using this for decades, and we effectively have 40 some odd different missions that we can point to, which is really, really powerful.

1:03:25A lot of these firms have decided they really only want to serve LPs that are doing social good in some way. And so whether it's scholarships or medical research or social equity or whatever it might be, there's someone in our client base that's really pursuing that objective. Number two is just burning shoe leather. We live on airplanes doing residencies in Europe, in the Bay Area. We have a colleague now who's in Singapore full-time covering Asia for us. There's just a lot of intensity that goes into the consistent need to top grade the portfolio. The sourcing construct is something that Jay brought over from his private equity days, which was this view that if your deal people are doing a deal, then your pipeline is running dry.

1:04:08And so you need a separate set of people that are constantly refilling that pipeline with compelling opportunities so that you know you are always in a position to be underwriting something. Deal finishes, there's something new in the pipeline. Maybe it's better than the thing you were just about to look at. That sort of thing has been really, really helpful in helping us turn over more and more stones, creating what I would call sort of micro brands within some of these niches. Independent sponsor is a great example, obviously. We were sponsors of this McGuire Woods conference. We've become known in that community as a funder of these types of sponsors.

1:04:43And we have a very compelling pitch because we can ultimately anchor their fund one. We can be full lifecycle investors, unlike others that play in the space, may want to take credit for the deal. Just a different dynamic. That's been really helpful. We get calls early from people who know that their friend's friend also did something similar three years ago, and we backed them. Talent follows talent. Those are the big ones. Continuing to lean on our client causes, amplifying the sourcing apparatus meaningfully, and enhancing the decision-making of the team, I would say, is the third one. We are a robust team.

1:05:20We very much focus on collaboration, culture. That's critical. It's not something you can do at mass scale, but making sure that information is flowing very rapidly, allowing a lot of autonomy to our team to look at things that are compelling, that meet their bar, do the work on it, send it up the flagpole, let us evaluate it. That's been really critical because you have to move quicker than you used to. I know some LPs where you could be at the firm for 10 years and you're still monitoring an old portfolio position that was three CIOs ago. And that's a recipe for a really stale portfolio. And we try and arm our very ambitious, talented people with autonomy to go out and find the next great thing.

1:05:59You mentioned that Jay had this idea that if your deal team is working on a deal, you need people to continuously sourcing it. Sounds like that could have come from a private equity firm. And I'm curious if there are other important lessons that you brought into your investment process that you learned from some of your managers? We are always trying to use the best of what we see in the GPs to inform our own work. Sourcing was one of those. I think some of the process structure and how we systematically vet opportunities has been something we've brought over from other experiences. And then really how we try to motivate and incentivize the team culturally.

1:06:43Look, we do not want to have a massive multi-office apparatus at any point in the future. The distractions of scale are really difficult to deal with for large firms. It goes back to consolidation. I understand the business logic of consolidating into a big apparatus. You can push product through, you can distribute more easily, you got this army of salespeople, their advisors, nobody has ever been able to explain to me the investment rationale. How does this help us find good GPs? How does this help us deliver investment excellence for clients? How does this help clients at all? So I think that commitment to staying a boutique, staying focused on the ultimate client objectives is really a critical piece of this.

1:07:32And that's something we obviously learned watching firms that we backed maybe outgrow their opportunity set or change their stripes or lose their culture or some of these things. Culture is a very finicky thing. You have to apply constant pressure to it to make sure it retains the shape that you want it to. If left to its own devices, it will go in all sorts of directions. And we are very conscientious about that and making sure the team is properly incentivized, that we hire well, that we train well, that we develop well and give people autonomy. That has been another lesson of the great investment franchises out there that have stuck to their knitting.

1:08:10Great, Matt. Well, I want to make sure I get a chance to ask you a couple of fun closing questions. What is your favorite hobby or activity outside of work and family? I love being in the mountains. I don't get to go as often as I once did in the past, but try and definitely imbue in my children a sense of peace and comfort in the wild and the outdoors. What's one fact that most people don't know about you? I am an avid and sometimes successful home gardener. We had an absolutely bumper crop of sun gold tomatoes this year, but I'll grow cucumbers, peas, carrots, Swiss chard, melons, all kinds of things.

1:08:43Just love the patience and the vigilance that that craft requires. Something you learned on West 12th Street? That's right. That's right. What's your biggest pet peeve? Well, since I flew here today, I can say one of them is people who listen to shows on their phones without headphones on. I had somebody next to me who was watching, I don't know, the third season of some Netflix show, just free and clear, which requires just a flagrant disregard for everybody around you. Professionally, it's arrogance. I think acknowledging that we've all had so much good fortune to end up in the position that we're in.

1:09:20If you can't do that, it just strikes me as very off-putting. Which two people have had the biggest impact on your professional life? One's my dad. This one's a little bit nuanced. He served in the army after college for a long while, was incredibly disciplined and regimented, just a workaholic through and through, was gone before we woke up in the morning, was home after we went to bed at night, and he probably did that for 30 years. I don't know that it helped his health, but whenever I'm feeling tired or fatigued, I always do remember his constant reminder to put your head down. Whenever things got difficult, put your head down.

1:09:55And that is the way through. I do try to balance that against the recognition that I want to see my kids and spend time with my family and do all the things that make me happy in life too. And who's the second? I'll credit partner at Goldman who took me under his wing pretty early in my career there and was instrumental in my having an ability to grow at that firm. A guy named Steve McGinnis, he was a terrific guy. Everybody needs somebody at some point to take a flyer on them and just find something about them that they appreciate and help them along the journey. And Steve was that for me early.

1:10:27What's the best advice you've ever received? The idea that passion comes from the pursuit of mastery, not the other way around. It's a big hoax out there that you're supposed to find what you're passionate about and then go do that. That's not where it comes from. The idea that you get up every day and try and get a little bit better at something, that's where passion comes from. All right, Matt, last one. And what life lesson have you learned that you wish you knew a lot earlier in life? Well, I'll give you one that I'm still terrible at, but I keep trying to get better. It's keep your friends close.

1:10:56We all go off in different directions these days. People come and go through your life and finding ways to stay in touch with people you care about who care about you is a critical source of mental health and wellness. And I continue to try to find the energy and time in my day to give people a call and check in on them and share how our lives are going. Matt, thanks so much for sharing these great deep and nuanced insights into what you do. Thanks so much, Ted, for having me. Appreciate it. Thanks for listening to the show. To learn more, hop on our website at capitalallocators.com where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more.

1:11:42Have a good one and see you next time.

1:11:48We'll see you next time.